It’s brutal out there. We had two very strong down days on Friday and Monday, with no signs of a relief bounce today. The S&P 500 Index closed down another 3.2% on Monday, now down over 16% year-to-date. Everyone expects we will enter official bear market territory, with the averages down 20% or more. CNBC began live primetime coverage called Markets in Turmoil last week and invited me to join. The bear market playbook is open.
Seeing red on the screens is never fun. To be honest, it doesn’t get easier with time or experience. I’ve come to view my job as an advisor as one who studies the human condition. We are not hardwired to withstand the pain of losses. Every fiber in our DNA wants to do something to stop that pain.
But if we could extract our emotions from our body*, we have to admit to ourselves that things were a little too rosy, for a little too long. The S&P 500 Index is up almost 700% since the bottom of the Great Financial Crisis and 50% over the last three years. Take a look at the last 6 years of annual returns for the index. This is not normal.
S&P 500 Index Annual Returns since 2016
Interest rates have been too low, almost zero, for too long. This free money paved a path for record-breaking investment in private markets. Dollars in search of yield moved out too far on the risk spectrum. Billions flowed into venture capital funds where the fear of missing out (FOMO) on the next unicorn outweighed analysis of an investment’s merits. It became normal for start-ups to blow through hundreds and millions of dollars in search of the pipedream of profitability far off in the future. And sometimes it worked. Uber and Airbnb have changed the way we interact with ground transportation and travel forever.
This run for growth stocks was incredible, but now it may finally be over. As a dyed-in-the-wool value investor, at times, it was downright maddening. I can’t tell you how many DIY investors I’ve spoken to in the past ten years who believed they had cracked the code on picking stocks. It was easy, just buy the ones that keep going up.
Then the pandemic hit, and we bred an entirely new generation of day traders. Fueled by commission-free trading and apps that make it too easy to trade on a phone, these traders felt like geniuses in 2020 and 2021. They were crafty, too. Congregating in online forums, they banded together to create MEME stocks like Gamestop and AMC. Fundamentals went out the window, and hedge funds even got in on the game.
Meanwhile, cryptocurrency is showing promise as a real shift in the future of financial assets. The concept of digital scarcity has wide-ranging implications for financial markets, the flow of international funds, and the future of global commerce. Here is where the excesses really flared. Pixelated photos of apes became a hot commodity worth millions of dollars. People were paying for video clips of basketball dunks. Throw your financial textbooks out of the window. This ain’t Fama or French’s financial market anymore.
There has been way too much exuberance in financial markets over the past 5 years. It’s time to flush it out. Flush it all out.
What we are experiencing in financial markets right now is akin to the cleansing feature of a forest fire. Fire does a lot of damage, but it serves a vital purpose for the future viability of the ecosystem. Organisms that were trapped under dry, dead debris will be able to make it to the surface again and grow. The nutrients from that fire will fertilize the soil below.
Breathe in, breathe out.
Let go of your urge to be in control. How could you be? You’re riding a rock that is hurdling 67,000 miles per hour through space.
A beautiful spring will grow from this destruction. Let the fire do its thing and clean out the junk.
* I borrowed this line from one of our founding partners, Kris Venne.
